Double materiality is a concept that refers to the idea that a company’s financial statements should report on not only the financial impact of its operations on the company itself, but also the impact of the company’s activities on society and the environment.
From a financial perspective, materiality is the concept that requires companies to disclose any financial information that could impact investors’ decision-making. In this context, a financial item is considered material if it is large enough to affect a company’s financial performance or if it could influence investors’ decision-making.
Double materiality expands on this concept by requiring companies to also report on the materiality of their operations’ impact on the environment and society. this means that companies need to consider the environmental and social impact of their business activities in their financial reporting, as these impacts may have a material impact on their financial performance.
For example, a company that relies heavily on fossil fuels may face financial risks in the future due to changing environmental regulations and the increasing focus on climate change. These risks may have a material impact on the company’s financial performance and should be disclosed in the financial statements.
In summary, double materiality requires companies to report not only on the financial impact of their operations on themselves but also on the impact of their activities on society and the environment.
How to perform a double materiality
Performing a double materiality assessment can be a complex process. Knowing where to start makes it so much easier. Here are seven steps to guide you through the process:
- Define the scope: Identify the scope of the assessment, including the company’s operations, products, services, and value chain. this will help to identify the sustainability issues that are most relevant to the company.
- Identify the sustainability issues: Identify the social, environmental, and economic issues that are most significant to your business (operations and value chain) and its stakeholders. this will involve gathering input from stakeholders and analyzing data to determine the issues that have the greatest impact on your business and society.
- Assess the financial impact: Assess the financial impact of each sustainability issue on the company’s financial performance including risks and opportunities. This will involve quantifying the costs and benefits of managing each issue, as well as estimating the potential financial risks associated with each issue.
- Assess the non-financial impact: Assess the non-financial impact of each sustainability issue on the environment and society, including both positive and negative impacts. This will involve evaluating the company’s impact on issues such as greenhouse gas emissions, water use, and human rights.
- Evaluate the significance: Evaluate the significance of each sustainability issue based on its financial and non-financial impact. This will involve prioritizing the issues that are most material to the company’s business and stakeholders. Quantify the financial, environmental, and social impacts of the identified sustainability issues.
- Develop action plans: Develop action plans to address the most material sustainability issues identified in the assessment. Use the results of the assessment to prioritize actions that will mitigate the negative impacts and capitalize on the opportunities identified. These action plans should include specific targets, timelines, and responsibilities for implementation.
- Monitor and report: Monitor progress on the implementation of the action plans and report on the company’s sustainability performance to stakeholders. This will involve ongoing monitoring and reporting to ensure that the company is making progress toward its sustainability goals and commitments. Communicate the results of the double materiality assessment to stakeholders transparently through sustainability reporting and disclosure progresses, verified by an accredited 3rd party.
By following these seven steps, companies can gain a comprehensive understanding of the material sustainability issues that impact their business and society, and take meaningful action to address them.
However, as mentioned, performing a double materiality assessment can be a challenging task, and there are several common mistakes that companies can make. Here are some of the most frequent mistakes to avoid:
The 5 most common mistakes when performing a double materiality assessment.
- Focusing only on financial impacts: One of the most common mistakes is to focus only on the financial impacts of sustainability issues and ignore the social and environmental impacts. This approach can result in an incomplete assessment that does not capture the full scope of the company’s impact.
- Not engaging with stakeholders: Stakeholders’ engagement is essential to understanding the material sustainability issues that are most relevant to the company and its stakeholders. Failing to engage with stakeholders can result in an incomplete and inaccurate assessment. Ask yourself these questions:
- Who are the stakeholders that are impacted by the organization?
- Which stakeholder can affect the organization?
3. Ignoring indirect impacts: Companies often overlook the indirect impact of their operations on sustainability issues, such as the impact of their supply chain or the products they sell. ignoring these indirect impacts can result in an incomplete assessment that does not reflect the full scope of the company’s impact.
4. Failing to quantify impacts: Quantifying the financial, environmental, and social impacts of sustainability issues is crucial for prioritizing actions and communicating the results of the assessment. Failing to quantify impacts can result in an incomplete assessment that does not provide a clear understanding of the company’s impact.
5. Not integrating the assessment into design-making: double materiality assessments should be integrated into the company’s decision-making processes to ensure that sustainability issues are considered in all business decisions. Failing to integrate the assessment can result in a disjointed approach that does not drive meaningful action.
By avoiding these common mistakes, companies can perform a more comprehensive and accurate double materiality assessment, which can lead to more effective sustainability strategies and improved business performance.
With the new EU regulation approaching (Corporate Sustainability Reporting Directive) there are some changes and challenges we would like to highlight:
Under CSRD the use of stakeholder input has changed. Whereas previously stakeholders were asked which topics they considered important, now they are asked to identify the organization’s most significant impact on people and the environment, and the most significant sustainability risk and opportunities for the organization. This is challenging because not all stakeholders will be able to compare and assess a broad range of ESG topics from these two perspectives.
The CSRD asks organizations to look at financial effects from two perspectives:
a) to what extent can you continue to use your current resources?
b) To what extent can you maintain your existing relationships?
This exercise requires an understanding of what is happening in the value chain, as well as insight into sustainability developments that can affect business processes. Such as; Will polluting activities be taxed more heavily? Will customers ask for other (more sustainable) products and services? What are the financial consequences of reputational risks as a result of possible human rights violations, fraud, and greenwashing?
Climate Change and (part of) Own Workforce (for organizations with >250 employees) are considered to be sustainability matters that are material to any organization within the scope of the CSRD. In addition, the standards within CSRD provide a list of sector-agnostic sustainability matters that organizations should consider in their materiality assessment. These issues could include climate change, water scarcity, human rights, labor practices, and supply chain management.
A couple of further recommendations for materiality assessment
The assessment of risks and opportunities requires input from a range of experts. Sustainability teams can help identify events that might trigger a risk or opportunity, e.g. new regulations, increased public scrutiny, or changing stakeholders’ expectations regarding a certain topic.
Risk experts can support and ensure alignment with the broad enterprise risk management approach.
Financial experts can help to assess the magnitude of the financial effect, e.g. increase in R&S expenses, loss of revenue, or increase in operational costs.
We would recommend bringing experts together in a workshop so they can challenge each other on the relative score of each topic and how that fits into the bigger picture.
Once all impacts, risks, and opportunities have been assessed, an organization can create separate ranked lists (high to low materiality scores) for negative impacts, positive impacts, risks, and opportunities. By applying a threshold or cut-off point these lists can be split in material (top) and not material (bottom) impacts, risks, and opportunities.
Here, the challenge is in setting the thresholds, since the CSRD and its standards provide very limited guidance on this. An organization should include all significant impacts, risks, and opportunities, but if too many are included, the sustainability statements and strategy will no longer focus on those topics that matter most. Therefore a dialogue with senior management and the experts involved is needed to develop a holistic view of the most material matters.
For each sustainability matter that has been identified as material, the CSRD requires that companies disclose exactly what measures they are putting in place to manage their environmental and social impacts. As a result, companies have to disclose not only the metrics and targets they have set for each sustainability measure, but also the policies and action plans they will execute to achieve their goals. To help you find focus in this matter, ask yourself the following questions:
- What do you want to achieve?
- how do you expect to do this?
In addition, the CSRD requires companies to make disclosures about how they account for sustainability matters in their strategic planning processes. This includes monitoring how significant impact, risks, and opportunities arise and what adaptation of business model, market position, and value chain is required.
In summary, these requirements lead to an increasing need to take into account sustainability effects and to take a longer perspective when the company’s strategy is developed.
The publication of action plans also requires that the companies articulate in a credible and transparent manner how they will ensure that sustainability issues are addressed in the organization and which parts of the organization need to be involved.
We hope these recommendations can help you in your work to perform a double materiality assessment for your organization. This will be especially important when the EU’s new sustainability law on reporting comes into force already next year.